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Best face forward

11/19/2000 07:00:00 PM Eastern


Dan Somers is in the middle of a financial bet that appears to be going wrong. The chairman of AT&T Broadband is shepherding a $100-billion portfolio of cable systems acquired in an attempt to transform parent AT&T. Somers' boss, AT&T Chairman Mike Armstrong, thought the takeovers of Tele-Communications Inc. and MediaOne Group Inc. were the way to shake the telecommunications giant from its reliance on long distance, a business that was shrinking fast. But, so far, Wall Street has focused mostly on the transformation of AT&T from a $60 stock to a $22 stock, prompting Armstrong to start splitting the company into five public pieces. AT&T Broadband would be one of those pieces. To Somers, that independence doesn't change much. His mission remains what it has been since he took charge a year ago. He must complete the rebuild of AT&T's systems so they can handle digital TV, data and telephone services. And he must improve cash flow. In this interview with

Broadcasting & Cable's Deputy Editor John Higgins, Somers says AT&T's cable strategy will pay off
given just a little more time.

AT&T Broadband is going to be separated from your parent. What does that mean for the master plan?

I don't think anything changes from our strategy at all. Our strategy in acquiring TCI and MediaOne was to bring the two companies together to finish the rebuild, to put a broadband network in place to deliver multiple services to our consumers. And I don't think anything changes at all.

It seems to me that telephone via cable was this incredible, strategic imperative for AT&T, more so than it would be for a truly independent company. Some other cable operators don't see it as much of an imperative as you do.

And I think they're wrong.

And they don't think you can get the return on investment out of circuit-switched telephone.

I think they're wrong. And I've felt that way from day one. I've deployed large cable telephone networks in the UK for Bell Canada competing against British Telecom. We got a 30% share of the market. The ROIs worked there, frankly. Telephone was more successful in the UK than video because of the entrenched position of Murdoch's satellite TV service.

My experience so far with telephony launches across our markets in the United States leads me to feel as strongly as I did when we started this. And I think, ultimately, you will see the industry provide voice services along with data and video to its customer base. You know, two of the big five are doing it now, AT&T and Cox, and are happy with it. And I think others, ultimately, will get there. That's my view.

Get there sooner rather than later?

I think they'll get there in their own course and time. Some sooner; some later. That's their decision, as a company, to make. I know our decision. When you put the network in place and you can deliver multiple services across that network, you increase your operating efficiency in time, you improve your revenue per connection in time. And, therefore, you improve your gross-margin dollars and your cash-flow dollars. And I don't think that's changing.

You've got some smart guys like Comcast and Cablevision in very low gear on this. As you separate from AT&T, doesn't that give you a moment of pause?

No, not at all.

So why are they not doing it? Are their return thresholds just higher?

Oh, you have to ask them; don't ask me. The greater return on invested capital, when you put in telephony and you get scale, is as good as any other product we sell.

What do you expect your ROI to be?

I've said that before. I expected that the long-term rates of return on the invested capital we're deploying will be 25% plus.

Which is great under any circumstance?

Exactly. We're a service-distribution company. We have an embedded customer base of 16 million people. We have 28 million homes in our footprint. We have a network that's local. We should be providing broad-base local voice, video and data services to our customers. And it's working. And the technology works. The deployment is working. And the upfront investment and the rewards are over a three-to-five-year period of time. And so this sense that our attitude is going to change on telephony is wrong.

Do you agree with the breakup plan?

I'm very supportive of it. From the broadband standpoint it's very positive. The same is true for wireless. The sense that there was going to be this great bundler in the center and heart of AT&T was, I think, a very wrong perception on the part of the investment community and the media. We will still bundle broadband voice, video and data services. Wireless is bundling voice and data services. That hasn't changed. We're not changing our course, our speed or our strategy. It's just that you want to invest in our industry, or you're more of a conglomerate of telecommunications services. And the boards decided to separate them into four (plus Liberty), and I'm supportive of that decision.

You were part of the force that was consolidating all this stuff to begin with. So why does it make sense to separate it now?

Remember, going back a year or a year and a half ago, we were going to have a separate sort of enterprise, and we decided not to do that because we felt that, operationally, it wasn't the right time to do it. And now, a year and a half later, operationally, it is the right time. Next year, we'll finish the last big year of our rebuild. Our focus is on scaling our services.

We should begin to see the efficiencies of the multiple services across the single network beginning next year. And improved revenue growth. You know, it's a good time to allow that enterprise the opportunity for a more independent valuation. And Mike Armstrong was clear two years ago when he laid out the criteria for why you would create separate entities or tracking stock. And it was operational fitness, currency required for expansion, and motivation to the group of executives and employees that are there. And I think all those are valid in our case.

In crunching your broadband operating numbers, I count new-media expenditures, which you treat as a discrete business. The TCI properties are now generating substantially less cash flow per subscriber than they had been before you bought them. Is that operational readiness?

Well now, those systems have shown two quarters of year-over-year cash-flow growth now. Second and third quarter of cash-flow growth was positive.

You're excluding the new-media and phone spending.

Yes. And it will be positive for this year, as a whole. It was only negative last year. And we've reversed that. Overall, you can't expand in the new products-whether it's data, telephony, advanced-video services, digital or video on demand-without upfront expenditures which have a negative impact on your cash flow, short term. But long term, they will generate positive cash flow. We're no different from anybody else in the industry.

Your systems are growing at a lower rate than those of your peers.

Well, I don't know. I saw Comcast's revenues for the third quarter. Overall, its broadband unit was up 8.6%; ours was 10.8. We had faster growth in new services, but I think we were both at about the same level-a little over 7%-on our basic video services.

In cash-flow growth?

No, in revenue growth. Cash-flow growth, they were a little bit stronger, absolutely. We made no secret of that.

That turns around next year?

Yes.

On the core video business, what have you changed since you all started managing the systems? What are you doing differently from TCI?

TCI, during the course of time, prior to the acquisition by AT&T, was pulling together a cluster strategy doing significant swaps of properties to tighten its clusters. It was the smartest thing they could do. I've said that before. [Former TCI President Leo Hindery] made a significant contribution to the company by doing that. He increased the value of the company by doing that. And, you know, that was being completed as the acquisition was taking place.

What we're trying to do, the current management team, is consolidate those markets from an operational standpoint. That takes time. Chicago was put together with five different properties. You've got to consolidate that. Consolidate operating centers, call centers, fulfillment centers. Consolidate management teams. The benefits of that consolidation will begin to accrue to us in the year 2001.

Some areas like Pittsburgh didn't need consolidation, and I'll put Pittsburgh up against any other cable operator in the company: very high penetration, very high cash-flow margins, good solid revenue growth. But it's only one market out of 16. When we combined Lenfest with Comcast's properties in Philadelphia, Lenfest was a very well-run company, had very good margins. It made sense to consolidate that. It was a smart thing to do as part of the overall transactions we did with Comcast.

But, there's got to be a sense of going back and looking at the fundamentals of this whole exercise. And that's just heavy lifting. That had to be done and we're doing it.

As you consolidate these markets, what do you see in terms of margin improvements of individual properties?

Well, overall, we've talked about next year looking at about three points of cash-flow margin improvement from around [32% to 35%]. And you can assume that the majority of that is through the consolidation of the markets and the operating efficiencies you get: field structure, field management, call-center consolidation, fulfillment-center consolidation, systems consolidation; those are sort of the operating things you have to do. They're not sexy, they're not the deals, they're not all the hype, they're not the buzz, they're not the bang. That's what I've got 45,000 employees working on right now.

But that stuff's sexy to us. We're impressed by the call-center stuff.

Well, good, you should be.

In a single market like Chicago, how much can you improve the margin?

We do not forecast individual market margins or improvement.

What's working operationally right now? What's not?

Well, what's working are the implementation of our new field structure where we eliminated multiple regions and consolidated into two much-smaller structures and tighter markets. And we're beginning to see the benefit of those. That's partly why the cash flow has improved from this year to last year. And, again, that's a month-by-month process that rolls into the next couple of years.

The other thing that's working is that we have gone beyond the point of digital being scaled. It is scaled. And that's having a positive impact on our video business. And we're scaling the other two products, telephone and high-speed Internet access. I wouldn't say anything's not working, you know? It's a matter of time.

How about basic-subscriber growth?

Well, you know, our basic subscriber growth is essentially flat. It's up a hair. You've seen some other companies have a little bit slower basic growth developing over the course of this year. I was at a management-committee meeting yesterday with our partners from Insight, who I think have sort of the same philosophy that we do, which is rebuilding your networks and developing your business across multiple services, and you can no longer look at one. You can do short-term things to boost your video sales, but they don't necessarily help you long term.

This industry's going to a multiproduct mode with its customers. Digital is critical. And I'd say if you look at digital,we not only lead the industry, we continue to grow at very rapid rates of deployment. That's a plus long run. And, you know, we tend to be the one company that's got the most overbuild competition, which takes some of the growth out of the market. And we're competing aggressively against them as well as satellite.

How are you finding your overbuilders right now?

Well, what they're doing is they're taking some of the market growth away. They're not taking a significant number of our customers away. They're getting some of the new growth in the markets. I personally believe that that's a tough business for the long haul. We've got a number of case histories. It's for overbuilders who haven't been able to get the penetration levels and the customer levels that they need to make their businesses sound financially long run. And we intend to compete aggressively so that overbuilders can't do that in our markets.

What's your tactical response to overbuilders?

Our tactical response is to upgrade our networks and roll out our new services, multiple services. That's the best competitive environment we can have. And it's the best competitive thrust.

What about for the stuff like Comcast does when RCN moves into town? It starts trying to sign people to really long-term contracts and starve the overbuilder?

Oh, we've done dish back-buy programs to deal with satellite guys. We've done aggressive promotional offers in the market where we felt an overbuilder was coming. We did a lot of aggressive marketing and market development activities in Denver, where Seren Innovations was planning to overbuild and decided not to. So it's a matter of a variety of things you do, not one specific thing.

Are you going to shed some assets, including your 30% stake in Cablevision systems?

I don't think there's been an announcement about that. There's speculation about that.

Try this. Do the minority interests in cable systems that you still have bring anything to the table?

The only comment that I would make about any of that is that we should-as a matter of our strategic plan and direction as well as looking at preparing to become a public entity-put ourselves in a position where we can be best compared to our peers. Makes sense. Therefore, if there are assets that we don't think in a public IPO are going to get the same value as they could get in a private transaction, those are going to be looked at. And we're in that process now. But I can't comment about any one asset in particular.

TCI's strategy for years was to park systems. They would invest in MSOs to get partial stakes and then roll it all up three, five, seven years later. Part of their consolidation growth wasn't simply takeovers, it was this process of staged investments and partnerships. Is that important to AT&T over five, six years? Or is that less important than it was?

Well, I think you have to assume or at least come to grips with two specific facts: one is what's going to happen with attribution rules, right? And, therefore, are you going to be allowed to have a level of ownership that's above where it is today. Right now, we couldn't, right?

Well, you're penalized for a lot of this stuff.

Yeah. But, I mean, you're penalized for holding the secondary assets where you don't have operational control, but there are current requirements of having ownership levels limited at where they are today. So it's tough to say that that ought to be a fundamental part of the strategy when you can't necessarily do that, right?

What happens in the long run is an issue that I think we're all going to have to look at. What ultimately happens with the attribution rules, long run. And are properties that we hold partnerships in likely to be acquired? I can't answer that. I mean, I don't think Cablevision is prepared to not be independent. So we have an equity stake. It's of great value. It's a very well-run company. We're happy to be owners of it.

But I can't predict what's going to happen in the long run. But I think that, clearly, we would like to see the attribution rules lifted. And, if they were, one would want to own outright more properties. But, that's got to be out in the future.

How upset are you about the slow rollout of advanced digital converters?

What slow rollout?

The delay in volume deliveries of the Motorola DCT-5000s with a Microsoft operating system that actually works.

I don't think there's wild disappointment on our part.

Why?

Well, because I don't think we ever intended to be in a heavy deployment of boxes. The DCT-5000 is an advanced box that we're hopeful to get in the test market. We're putting it in one market later this year, very shortly. And then it goes in other markets next year. Not particularly disappointed with the status of that.

You've committed to buy 3 million of these things.

Yeah. I don't think we've changed that commitment.

Wouldn't you have wanted a more aggressive rollout, or at least a freer availability of the units?

It takes time to do these things. And we want to do them right, and we are doing them right. We've expanded the manufacturing base of the box to include Philips and Matsushita, long run, along with Motorola. We've got multiple suppliers of software working on the platform with us. We'll do a multitude of tests with those suppliers. We're going deeper and looking at how we can embed technology into our current family of DCT-1000s or 1200s and 2000s to make those more interactive with VOD and other things. I think our effort in interactive is right at the top of our development efforts. But we're not expecting it to be a significant source of revenues in the next year or two.

You're a believer in VOD, correct?

Absolutely.

What about programming costs? Can you really get any movement there? There's a lot of grousing from other MSOs that TCI saddled everybody with some very expensive contracts.

Well, programming costs are going up in a variety of areas, and I don't think any of us are thrilled with that. And, as an industry, we're going to have to look long and hard at that part of our business, and look at ways where we could mitigate the cost increases over a longer period of time. I think as you move into interactive television, as you move into different areas, the relationship with programmers will logically change, and I think it's in all of our best interests to work more closely together and partner more closely together.

And I think you'll start to see some of that. We both need each other, you know? I mean, I can't go into the business of creating brand-new content right now, and our viewers like lots of what they see. So we've got to work more closely together. And I think we will.

So you're not sweating the escalation? You don't think the programming costs are going up too high?

As an industry, it's a part of our cost structure that we have to deal with. And I think we have to deal with it together to the extent that we can, and understand the impact that it has on our business. But I don't think it's something that one ought to go to war over, personal opinion. So you've got to work with people.

Open access, what do you think will come out of the Time Warner-AOL negotiations with the FTC? And do you think that will end up applying to you or just applying to them?

I think it'll apply to them. I don't see any reason why it ought to apply to us, per se. We've got our own rules we've got to live by coming out of MediaOne and TCI acquisitions, which we will. But I also think we have taken a very clear position on open access and have tests under way right now.

This is one area where other MSOs are hopeful about the split-off of AT&T broadband. They hope that as AT&T becomes more of a cable company, that its agenda will much more closely reflect that of other cable companies, that it will not be balancing the needs of the other divisions.

Yeah, but what does that mean? Does it mean we can put our head in the sand about open access? I think that would be a pretty wrong attitude.

It means you might not agree to an open-access deal as favorable as the one you did with Mindspring/Earthlink in the midst of the MediaOne approval process.

We got through all of the MediaOne approvals without open access being a mandated situation. We fought hard for that. Hard for that on our behalf, but also hard for that on behalf of the rest of the industry. So, you know, we all have to, I think, have a realistic attitude that there's going to be some form of open access occur in our markets, we're better off controlling that ourselves, rather than have the government control it. And I think we're undertaking the necessary steps to be able to do that.

You're going to stay in this job after the separation?

I hope so. I mean, yeah. What more can I say? I'm in it now. I like what I'm doing. I'm having fun. I think we're making a difference. So, yeah, I'd love to continue to do it.

What does next year pose for you?

Doing what we need to do. And our focus is operationally on our business. That's where we try to keep focused. It's the most important thing we can do right now. It's best for AT&T shareholders and best for the ultimate value of broadband at the time it goes and becomes a public company. Someone ought to some day take a look at what our markets and our assets really are. It's a hell of a collection of assets. And great markets. And that ultimately will bring significant value to the company when we've done that.

The company seems to be beaten up-AT&T seems to be beaten up-partly because of broadband.

Yes and no. WorldCom is beaten just as badly, if not worse, than AT&T. Sprint's beaten up. Those three are beaten up. And it's because of what's occurring in long distance. Everybody likes to jump in and take a jab at broadband. But if it were just us, maybe you could say that. But I think now you've got to do a little more homework and look again at what's happening in the telecommunications industry, overall.

Meanwhile, I think the cable operators are continuing ahead with deploying their new products, refinishing the rebuilds of their networks, focusing on their operations, and that's a good story, you know? We're not dependent upon all the pizzazz; we're a basic core distribution and service company that has a pretty healthy business that's growing and its growth rates are improving. That's a great position to be in.

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